* Graphic: World FX rates in 2019 tmsnrt.rs/2egbfVh
* Graphic: Trade-weighted sterling since Brexit vote tmsnrt.rs/2hwV9Hv (Adds Merkel comments, updates prices)
By Tom Finn
LONDON, Feb 4 (Reuters) - Sterling strengthened on Monday after a newspaper report said that goods shipped to Britain from the European Union could be waved through without checks in the event of a “no-deal” Brexit.
The Sun newspaper report that British customs will avoid checking goods from the EU for a temporary period to avoid hold ups at ports sent the British currency over the $1.31 line.
For investors the report may alleviate some concerns about the extent of possible disruption to Britain’s economy in the case of a potentially chaotic no-deal Brexit.
The British government later said most goods arriving from the EU will be allowed into Britain without full customs checks for at least three months if it leaves the bloc without an exit deal.
Sterling had weakened earlier in the session as Prime Minister Theresa May met lawmakers to try and overcome a parliamentary impasse.
In a sign of a possible move towards breaking the deadlock, German Chancellor Angela Merkel on Monday called for a “creative” compromise to allay concerns over the future of Irish border arrangements.
The pound has held on to most of the gains it racked up in January despite there being less than two months until Britain is due to leave the European Union on March 29 and with no agreement governing future ties with the bloc secured.
But concern is mounting about the risk of a no-deal exit and that is showing up in derivative markets which are predicting more currency volatility in the coming days.
Investors have ramped up purchases of two-week options taking into account the dates when British lawmakers meet while two-month risk reversals, a ratio of puts to calls on a currency, have shown increasing signs of caution for the pound.
“One month implied volatility has been coming off quite a bit ... it’s still relatively elevated but in view of how close we are to Brexit, and all things that can happen in between, you could argue there’s a bit of optimism there,” said Neil Mellor, a currency strategist at BNY Mellon.
May aims to get parliament’s approval for a revised deal on Feb. 13. If that fails, parliament will vote on next steps on Feb. 14.
“We’ll probably see another week of intransigence out of Brussels, keeping those ‘no-deal’ fears on the table,” said Chris Turner, head of foreign exchange strategy at ING in London.
“GBP might stand a better chance of recovery next when those amendments may return for a vote in parliament and a ‘no-deal’ is formally taken off the table. Cable risks drifting to $1.2920,” he added.
At 16:50 GMT sterling was down 0.1 percent against a broadly strong dollar at $1.3062 and flat against the euro at 87.52 pence.
On Friday sterling suffered its biggest weekly loss since mid-December partly because of survey data showing uncertainty sweeping British manufacturers ahead of Brexit.
Money markets have cut the probability of a Bank of England December interest rate rise to around 55 percent, versus 62 percent a week ago.
Little clarity on rate hikes is expected at the central bank’s policy meeting on Thursday. Rates last went up in August 2018, and the next move likely hinges on how Brexit plays out.
Additional reporting by Sujata Rao; Editing by Janet Lawrence and Jane Merriman